May 27 (Bloomberg) -- The Bank of Korea should keep its
benchmark interest rate unchanged as escalating military tension
with North Korea and Europe’s debt crisis have shaken investors’
confidence, the head of a state-run research institute said.

“It’s not a good idea to raise rates now,” Hyun Oh Seok,
president of the Korea Development Institute, said in a May 26
interview in Seoul. “It will only stir more turmoil.”

Pressure on the central bank to raise rates has been
increasing as growth accelerates and policy makers from India to
China tighten monetary policy. The Bank of Korea on May 12
dropped the phrase “for the time being” from its yearlong
commitment to keep an easy policy stance.

“It remains to be seen how the North Korean issue and the
European case develop and affect our economy,” said Hyun, a key
economic adviser to policy makers at the central bank and in the
government. “I’m much more concerned about the possible fallout
of the debt crisis in southern Europe as it could jeopardize the
still fragile global economic recovery.”

The bank needs to draw up well-designed exit strategies to
contain inflation as the key rate is very low and the economy is
approaching its growth potential, Hyun said. He said the
“normalization” of rates should be done at a gradual pace. The
bank cut the rate to a record-low 2 percent in February 2009.

South Korean government officials have repeatedly said that
it’s “too soon” to raise borrowing costs as the economy still
faces many uncertainties, including Greece’s debt crisis.

Robust, Resilient

Hyun said he expects the economy will grow 5.9 percent this
year on strong exports and domestic demand. It expanded a
faster-than-expected 1.8 percent in the first quarter and the
Bank of Korea projects 2010 growth of 5.2 percent.

“Our economy is very robust and resilient,” Hyun said.
“The government should try to earn more confidence from
investors with consistent and predictable policies.”

Inflation pressure will build up fast “soon” as the
domestic economy strengthens and a recovering global economy
drives up raw material prices and other costs, Hyun said.

Inflation will reach 3 percent this year from 2.8 percent
in 2009, the institute forecast. That would still be within the
central bank’s target range of between 2 percent and 4 percent
on average for the three years to 2012.

The won will likely regain its strength once Europe finds
some stability and investors return to looking at economic
fundamentals, Hyun said, calling for a careful approach when the
government intervenes in the market.

“The general trends are for a firmer won,” said Hyun.
“Both the foreign-exchange authorities and investors should
decide whether its recent decline was caused by economic
fundamentals or one-time passing events.”

The currency plunged to a 10-month low this week after a
defector group reported North Korea’s military was ordered to
prepare for combat on May 20, when South Korea said its
communist neighbor was responsible for the March sinking of a
warship in which 46 sailors lost their lives.

South Korea’s government and central bank pledged
coordinated action on May 26 to keep the won stable, promising
to take prompt measures including supplying sufficient foreign
liquidity. The commitment helped to ease the slide in the won.